Border Walls And Taxes: Bad Medicine For Wrong Diagnosis – Analysis

Republicans pause on border walls and tariffs – as realization sets in about reduced profits, higher prices for US consumers.

By David Dapice*

While some critics say the proposed wall in remote border stretches will accomplish little at great cost, even conservatives worry that a tariff on Mexican goods is a tax increase that will fall on US consumers and disrupt a tightly integrated auto market. More generally, proposed tax changes aim to shift the burden of taxes to consumption, while benefit cuts paying for income tax reductions would, on balance, hurt most groups in the bottom 90 percent. None of this will help US manufacturing output or jobs.

US President Donald Trump has proposed, as a way for making Mexico pay for the multibillion dollar wall along the US-Mexican border, a tax on Mexican imports. Even a 2 percent tariff – just a tenth of the 20 percent rate floated as a possibility – would raise more than $5 billion a year. Over four years, that could pay for the wall.

But Mexicans would not necessarily pay for the tariff.

To economists, this is a familiar problem and a question of tax incidence. Say that you live in a city with a hot rental housing market and the city raises real estate taxes. Of course, the owners of the rentals write the checks for the taxes, but most simply pass on the costs to renters by raising monthly rates. Renters end up paying for the tax increase.

A tax on Mexican imports would prompt US consumers to seek substitutes – there may be alternative beers but few alternatives to consumers who like tequila. For tomatoes and other fresh vegetables, the price of alternative supplies may be quite a bit more expensive than Mexican tomatoes and in that case US prices would rise to offset the tax. If that were the case, US consumers would pay the tax, much like the renters in the previous example. This is the most likely outcome for the most part if tariffs are raised and would also raise prices for vehicles, machinery, mineral fuels and medical instruments – Mexico’s leading imports to the United States.

Keep in mind that the economies of the two nations are closely tied, so if Mexico exports more to the US, the country also tends to import more from the US. This is not equally true of China or Germany.

Mexico is currently the third largest US trading partner in goods, with $531 billion in trade during 2015. Mexico’s imports from the US were 80 percent of their exports to the US in 2015. China’s imports from the US are 25 percent of their exports to the US and Germany’s ratio was about 40 percent.

Shooting one’s foot? US exports to Mexico – and related US jobs – have grown at a faster pace than the trade deficit since NAFTA went into effect in 1994; while data for trade in services are not available, the US now has a trade surplus in that area (Data: US Census and US Trade Representative’s office)

So if the United States wants to export more, then it should divert trade to neighbors like Mexico and Canada that buy more of what we sell. Of course, if every nation acted on the impulse to impose tariffs in retaliation for a bilateral trade imbalance, tariffs would escalate and trade would shrink. There is no economic rationale to demand that trade be balanced with each nation engaged in trade. But hitting Mexico is a bad idea even if the mercantile impulse, favoring exports and wanting to depress imports, guided policy. In the North America Free Trade Agreement, the US export-to-import ratio is 87 percent versus 59 percent for non-NAFTA, as reported by US Census data for goods traded in 2015.

One purpose for NAFTA is to help integrate Mexico’s economy into the global trade network and create jobs that lessen the need for young Mexican worker to migrate north. Since 2008, estimates of net Mexican migration to the United States have been negative. The flows of migrants have been mainly from Central America fleeing gang violence. Mexican and US governments have cooperated to stop those flows. If relations deteriorate, it is likely that these illegal flows will increase. Tunnels can be built under walls, and the United States would struggle if Mexico dispensed with border enforcement.

Another angle to consider are the flows of goods back and forth across the border. Autos typically involve parts from many countries – even the most “American made” vehicles only have about 75 percent US content and these include some from Toyota and Honda, not just General Motors. Putting high tariffs on the trade in auto parts would drive up the price of US vehicles and make billions of dollars of factory investments and millions of jobs uneconomic.

The goal may be to restore US factory jobs, but here is the real problem with plans for the wall and the antagonism to trade: Most job losses in manufacturing were due to automation rather than trade or migrants. Most responsible estimates of the decline in factory jobs put automation at 80 to 90 percent of the decrease, with trade representing perhaps 10 percent and migration much less. Most illegal migrants work in services or construction, as do most US workers. Relatively few work in factories. To reduce migration and trade as the cure for rustbelt problems is simply wrong. The disruption to trade and the retaliation from trading partners are likely to increase the costs of the wall/tariff approach with few benefits for the workers with a high school education or less, about 60 percent of the population, who have been left behind in recent decades.

Of course, the wall is only part of the overall economic approach likely in the new administration. Virtually all Republicans want income tax cuts that largely benefit the rich. To pay for tax cuts and promised spending on infrastructure, some suggest a border tax that would not allow deduction of imports for calculation of income taxes on profits while removing exports profits from taxation. Taken together with income tax cuts, this would shift the burden of taxation onto consumers and away from those with high incomes with high savings. Many anticipate higher interest rates as a result of these policies, and this again would favor the wealthy relative to borrowers, as the upper tenth of households have 63 percent of financial assets, according to Federal Reserve surveys. Republican proposals also include cuts in subsidies for health care, education, housing and even retirement benefits, and this in turn would shift income from the poor and middle classes to the upper 10 or even 1 percent of the population.

In this context, the emphasis on a wall with Mexico and tariffs on trade can be seen either as a cynical political diversion or a case of poorly grasped causality. If the major problems have been caused by automation and poor and insufficient education, the proper response is to help workers and communities rather than try to cling to jobs that will not materialize. Subsidies for courses in community colleges, including for older workers, to earn reasonable wages in other jobs would be better than bullying companies to keep jobs here and, as a result, become uncompetitive compared to corporations elsewhere which are free to make the best choices for low cost production. Increased input costs and a strong dollar would depress manufacturing output and jobs.

Overall then, aside from the meager people-smuggling control benefits of the wall , the plans to pay for the wall with higher tariffs on Mexican goods fail every test even in Trump’s own terms. The wall and the resulting trade tensions would weaken US competitiveness and be economically disruptive, leading to more costs for US consumers and producers while not addressing the real problems confronting the nation or the workers who voted for Trump.

*David Dapice is the economist of the Vietnam Program at Harvard University’s Kennedy School of Government.

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